OxfordAQA A-Level Business: Deciding on a strategic investment (9725) – Revision Notes

These notes condense section 3.4.3 Deciding on a strategic investment of the OxfordAQA International AS and A-level Business (9725) specification, Version 1.1, for International AS exams May/June 2027 onwards and International A-level exams May/June 2028 onwards. Every outcome here is International A-level only, and Unit 4: Business strategy is where it is examined. Candidates still following 9625 should take their content from the 9625 document. For full explanations and longer worked examples, go to the study guide.

Once these feel secure, try the practice questions. Whole-course links: 9725 hub and printable 9725 checklist. The free diagnostics show which topics need more work. A short expected-value example also appears in the what is business study guide.

What the specification lists

Decision trees

1. Complete, amend and interpret simple decision trees.
2. Calculate expected values and net gain.
3. Limitations of decision trees.
4. The value of using decision trees.

Investment decisions 5. Meaning and significance of investment. 6. Calculate and interpret payback period, average rate of return and net present value. 7. Factors influencing investment decisions: investment criteria, non-financial factors, risk, uncertainty, business confidence and opportunity cost.

Key definitions

• Investment: spending now on assets (equipment, premises, technology, research) to earn returns later.
• Investment appraisal: methods that judge whether an investment is financially worthwhile.
• Decision point (square): where the business chooses between options.
• Chance node (circle): where outcomes depend on events outside the firm’s control.
• Expected value: the probability-weighted average of the outcomes of an option.
• Net gain: expected value minus the cost of the option.
• Payback period: how long a project’s net cash inflows take to cover its initial cost.
• Average rate of return (ARR): average annual profit as a percentage of the initial investment.
• Net present value (NPV): total present value of future net cash flows minus the initial investment.
• Discount factor: the number that converts a future sum into its value today at a given discount rate.
• Investment criteria: targets set in advance that a project must meet.
• Opportunity cost: the next best alternative given up.

Formulas

What	How
Expected value	Σ (probability × financial outcome) at one chance node
Net gain	expected value − cost of the option
Probabilities at one chance node	must sum to 1
Payback (part year)	full years + (amount still needed ÷ next year’s cash flow) × 12 months
Total profit	total net cash inflows − initial investment
Average annual profit	total profit ÷ number of years
ARR (%)	(average annual profit ÷ initial investment) × 100
Discount factor, year n at rate r	1 ÷ (1 + r)ⁿ
Present value	each year’s cash flow × that year’s factor
NPV	sum of present values − initial cost

Method in steps

Decision tree

1. Fill in any missing probability: 1 minus the others at that node.
2. At each circle, multiply each outcome by its probability and add.
3. At the square, subtract each option’s cost to get net gain.
4. Choose the highest net gain, then question the estimates.

Payback

1. Build a cumulative cash flow column starting with the cost as a negative.
2. Find the last year the total is still negative.
3. Divide the amount still needed by the next year’s cash flow; multiply by 12 for months.

ARR

1. Add all net cash inflows; subtract the cost to get total profit.
2. Divide by the number of years.
3. Divide by the initial investment; multiply by 100.

NPV

1. Multiply each year’s cash flow by its discount factor.
2. Add the present values.
3. Subtract the initial investment. Positive means the project beats the discount rate.

Small worked reminder

A café chain, Ashmoor Bakehouse, spends £36,000 on an oven that returns £12,000, £15,000 and £18,000 in years 1 to 3.

Cumulative: -24,000 (yr 1), -9,000 (yr 2), +9,000 (yr 3)
Months into year 3 = (9,000 / 18,000) x 12 = 6
Payback = 2 years 6 months

Interpreting and amending

• Interpreting a tree: the highest net gain is the numerical answer, but check the worst outcome, the gap between options and how reliable the probabilities are.
• Amending a tree: change one cost, outcome or probability, rework the affected branch, and see whether the recommendation switches. If a small change flips it, the decision is sensitive and needs more evidence.
• Interpreting appraisal: set each result against the firm’s criteria and against the other options, not in isolation.

Must-know distinctions

This	Versus that
Expected value: the weighted average result	Net gain: expected value after the cost is taken off
Risk: outcomes and probabilities can be estimated	Uncertainty: outcomes or their chances cannot be measured
Payback: measures speed of return (liquidity)	ARR: measures profitability
ARR: ignores when the cash arrives	NPV: allows for the time value of money
Positive NPV: earns more than the discount rate	Negative NPV: earns less than the discount rate
Investment criteria: the firm’s own targets	Appraisal results: the project’s figures checked against them

Limitations and value of decision trees

Limitations: probabilities and outcomes are estimates that may be biased; timing of returns is ignored; few outcomes can be shown; qualitative factors are left out; expected value ignores whether the firm could survive the worst outcome.

Value: forces managers to list options and outcomes, including doing nothing; gives a numerical basis for comparison; can be amended to test “what if” changes; encourages thinking about what could go wrong.

Factors influencing investment decisions

• Investment criteria: a project may pass on one method and fail on another; managers decide which target matters most.
• Non-financial factors: staff, community, environment, brand image, fit with mission and objectives.
• Risk: can be estimated with probabilities, so decision trees help.
• Uncertainty: cannot be estimated, so judgement and flexibility matter more than the numbers.
• Business confidence: high confidence brings more investment; low confidence delays projects even with positive NPVs.
• Opportunity cost: every project should be compared with the best alternative use of the funds.

Quick self-test

1. Quorrin Logistics has a 0.3 chance of winning a contract worth £80,000 and a 0.7 chance of earning £25,000 instead. The option costs £30,000. Calculate the expected value and net gain.
2. Three branches leave a chance node. Two have probabilities 0.15 and 0.6. What is the third?
3. Pellidge Laundry spends £80,000 on machines that bring total net cash inflows of £104,000 over five years. Calculate the ARR.
4. Corrowin Solar invests £20,000. Net cash flows are £9,000, £9,000 and £6,000 in years 1 to 3. The 5% discount factors are 0.952, 0.907 and 0.864. Calculate the NPV.
5. What does a discount factor of 0.907 for year 2 mean?
6. Which two appraisal methods ignore the time value of money?
7. Give one reason a firm might reject a project with a positive NPV.
8. Explain the difference between risk and uncertainty in one sentence.
9. Why might falling business confidence reduce investment?
10. A firm sets a maximum payback of 3 years. A project pays back in 3 years 5 months. Does it meet the criterion?

Answers

1. EV = (0.3 × 80,000) + (0.7 × 25,000) = 24,000 + 17,500 = £41,500. Net gain = 41,500 − 30,000 = £11,500.
2. 1 − 0.15 − 0.6 = 0.25.
3. Total profit = 104,000 − 80,000 = 24,000. Average = 24,000 ÷ 5 = 4,800. ARR = 4,800 ÷ 80,000 × 100 = 6%.
4. Present values: 8,568 + 8,163 + 5,184 = 21,915. NPV = 21,915 − 20,000 = £1,915.
5. £1 received in two years’ time is worth about £0.907 today at that discount rate.
6. Payback and ARR.
7. Any one: high uncertainty, a poor fit with the mission, harm to staff or reputation, or a better alternative use of the funds (opportunity cost).
8. Risk can be measured with probabilities; uncertainty cannot.
9. Managers doubt that the forecast demand and cash flows will happen, so they delay spending.
10. No: it takes 5 months longer than the target.

Where marks are usually lost

• Comparing expected values when the options have different costs; net gain is needed.
• Leaving a probability out of an amended tree, so branches no longer sum to 1.
• Giving payback as a decimal (2.5 years) when the context needs years and months, or converting 0.5 years to 5 months.
• Dividing total profit, not average annual profit, by the initial investment for ARR.
• Using total inflows instead of profit in the ARR calculation.
• Forgetting to subtract the initial investment at the end of an NPV.
• Stating “accept, the NPV is positive” without weighing risk, uncertainty or non-financial factors.
• Mixing up risk and uncertainty in an evaluation.
• Mentioning opportunity cost without naming the alternative that is given up.

Official syllabus

OxfordAQA International AS and A-level Business (9725) specification, Version 1.1, for International AS exams May/June 2027 onwards and International A-level exams May/June 2028 onwards. Published by OxfordAQA.